In business, you want to know how much you spend, earn, and how much is left. When working with a nonprofit organization, you also want to make sure that your income and expenses are allocated. Fund accounting is a method used by a nonprofit organization that illustrates accountability rather than profitability.
Organizations that receive income from public and private funding sources use an accounting system rather than traditional business accounting methods. Fund accounting refers to the management and distribution of income that an organization receives from donation programs, tax payments, grants, and other sources. The primary idea behind fund accounting is to track and document the use of assets donated by outside parties. Fund accountants keep track of the limits placed on each donation received by the organization to ensure that the money is used appropriately. In many cases, donations made to nonprofit organizations must be used to pay for a specific project or purpose.
Government agencies at different levels also use these methods.
Under accounting methods, the government can only use tax revenue to pay its general administration and its services. When government spending exceeds tax revenue, a budget deficit is created.
The goal of most nonprofit organizations and government agencies is to avoid budget deficits while delivering the most significant benefit to society through the strategic allocation of available resources. Accountants diligently ensure that the public funds are used as efficiently as possible to maximize the potential benefit from every dollar.
Definition of Funds
A fund is an area or goal in your organization that needs to be tracked separately from everything else. This includes but is not restricted to:
- Unlimited, temporarily limited, and permanently limited net assets;
- Trust funds;
Common Types of Funds
The following are funds examples are commonly used for personal enterprises:
- Emergency funds are created by individuals and cover periods of financial hardship such as job loss, prolonged illness, or significant expenses. The emergency fund contains at least three months of net income.
- College funds are usually tax-advanced savings plans set up by families to provide funds for their children’s college expenses.
- Trust funds are legal arrangements created by a grantor who appoints a trustee to manage assets of listed beneficiary value for a specified period. The fund is transferred to beneficiaries.
- Pension funds are savings funds used by individuals for retirement savings to receive monthly income or pensions.
In the field of investment, some types of funds include:
- Mutual funds are managed by professional managers who invest funds from individual investors in stocks, bonds, and other assets.
- Money market funds are liquid mutual funds purchased to earn interest by investors through short-term, interest-bearing securities such as Treasury bills commercial paper.
- Exchange-traded funds are similar to mutual funds and traded on public exchanges similar to stocks.
- Hedge funds are investment vehicles for high-net-worth individuals and organizations to increase returns on investors’ pooled funds through high-risk strategies such as short selling, derivatives, and leverage.
- Government bond funds are for investors who want to invest their money in low-risk investments such as Treasury bonds or agency-issued debt. The US government supports both options.
The government also creates funds that are allocated for various reasons. Some government funds include:
- Debt service funds are earmarked to pay off the public debt.
- Capital Projects Fund resources are used to finance a country’s capital projects, such as purchasing, construction, or repairing equipment, facilities, and other capital assets.
- Permanent funds are investments and other resources that the government cannot cash out or spend.
However, the government generally has the right to spend any income generated from these investments on the relevant government functions.
Fund Accounting Importance
Nonprofit organizations need fund accounting to keep track of many different restrictions, designations, and income and expenses sources. To accurately report the use of funds to (and build trust with) their donors, nonprofits need a transparent and efficient accounting method.
Fund accounting is essential for nonprofits growth. When nonprofit organisations talk about growth, they are talking about expanding their reach and services. However, with development, accounting needs are changing.
As the nonprofit grows, it becomes essential to organize all of the information in a way that is easy to understand. It is necessary to make sure that you:
- Transparent with sponsors. Nonprofits found the need to become more evident as they grow. Accurate accounting with a comprehensive ledger, payroll tracking, and budget management ensure you can provide your donors with the most up-to-date information.
- Report effectively and often. Nonprofits change their reporting methods after they’ve grown and have to report to their donors. When your funds and budget are well organized, these reports become easier to complete promptly.
- To make sure the nonprofit meets your growth needs, you’ll need fundraising software that offers a complete solution from transparency to accountability. When the software takes care of all the needs, you can measure all the metrics you need with minimal effort.
- As the organization grows, auditing becomes more critical. Even if you don’t need to conduct regular audits, doing so can help your nonprofit recognize the strengths and weaknesses of how you structure your finances.
An audit from an external source prepares the organization’s growth: over time, regular audits will improve your ability to raise money, launch practical projects, and fulfill your mission effectively.
Fund Accounting Benefits
Nonprofit organizations need fund accounting to optimize their needs. It provides a single system that tracks multiple variables and all specifications for each variable.
This single system improves the efficiency of your nonprofit’s accounting and makes it easier to stick to your budget. Variable and limited funds can make navigating your budget difficult, but our Roadmapping resource can help you organize your non-commercial use funds.
This basic accounting will help your organization:
- Plan fundraising initiatives. Nonprofits can better plan how much money it needs to raise specific projects. This basic accounting will help your organization:
- Stay transparent with donors. When the organization has well-organized and accurate information, donors will better understand your financial situation and keep track of it.
The nonprofits fund accounting benefits:
- simplified accounting leads to increased efficiency, which leads to more accurate budgeting,
- transparency with donors through reports.
These reports will help you become more efficient in your fund’s accounting.